What is a Cryptocurrency? Learn how it works
7 min read
What is a cryptocurrency?
Cryptocurrency is a decentralized digital currency that runs through blockchain technology. Most of us have seen currency in the form of paper notes or coins, but cryptocurrencies are a virtual currency that does not exist in the physical form.
This currency is decentralized. Now, most of you may be thinking, about what is decentralized. Let me explain!
All the different currencies that are being used all over the world are controlled by the banks and governments of the respective countries. The currencies are being controlled by a controlling body. Whereas cryptocurrencies are decentralized currencies which means they are not controlled by any controlling body, neither the banks nor the government. That’s the beauty of cryptocurrency.
Now let us know,
How did cryptocurrencies got started?
Before knowing how cryptocurrencies got started, first let us know where did the name cryptocurrency come from?
Cryptocurrency's name came from the word cryptography. Cryptography is a process that is used to secure information through codes. So, due to this, no other person can access someone’s information. Here “Crypt” means “hidden”. Similarly, Cryptocurrencies are digital currencies that are run through blockchain technology, where someone’s information cannot be accessed by someone. It can also be called hidden currency.
The first cryptocurrency was bitcoin which was launched by an individual or group pseudonym “Satoshi Nakamoto“. In 2008 he published a whitepaper on bitcoin. If you want to read it, you can check it out here.
He described Bitcoin as a Peer-to-Peer Electronic Cash System. Through this one can send payment to the other person without going through a financial institution.
Types of Cryptocurrency
The very first cryptocurrency is bitcoin and after the success and popularity of bitcoin, many other cryptocurrencies started coming to the market.
According to Google, there are currently over 4000 different cryptocurrencies in the market. The second most popular cryptocurrency after Bitcoin is Ethereum. It holds the second highest market cap after bitcoin.
As of August 2022, the total market capitalization of bitcoin is more than $400 billion.
Some of the other popular cryptocurrencies are Ethereum, Tether, Dogecoin, Cardano, etc.
How did cryptocurrencies become so popular?
After the success of bitcoin, people started becoming more aware of the new currency. It was a very new concept and it completely changed the way we look at currencies.
This currency is decentralized and is not controlled by any central authority. Due to this people have another option of not depending upon financial institutions.
As said above bitcoin is a Peer-to-Peer Electronic cash system that is nothing but computers connected around the world to carry out transactions. They are secure and one individual cannot control the transaction.
Due to these reasons, cryptocurrencies are popular.
How does cryptocurrency work?
To know how cryptocurrencies work we have to understand what is blockchain.
Cryptocurrency is being run through blockchain technology. Blockchain as the name suggests is a database. But here the data is stored in the form of blocks and all the blocks are chained together to form a chain.
Blockchain is the technology behind bitcoin and other cryptocurrencies that makes them so secure. To understand the working of cryptocurrencies we will take the example of bitcoin. Although every cryptocurrency works in a different way some core concepts are the same for everyone.
Let’s take a real-life example and understand it. You are playing cricket along with your other three friends. Now while playing you realize you don’t have anyone to count your scores. So, one of your friends suggested that he is going to get one person who would count their scores and wickets in the match. But then you realize that you cannot trust the other person and he/she may manipulate the scores. So, you come up with an idea that all the players would keep a piece of paper with them and each one would update the score after every ball and when the game will be overall would compare the 4 pieces of paper and then decide who won the match. If someone manipulates the score, it would not change on the other 3 papers, and in this way, no one can cheat.
Similarly, this is the way in which blockchain works. There are a lot of computers that are connected peer-to-peer. They are known as nodes. Today there are over 47000 nodes all around the world.
All of the computers maintain a ledger that has records of all the bitcoin transactions that have happened. Whenever any transaction happens every 10 minutes it is shared with the nodes and the transaction gets recorded in every copy of the ledger of all the nodes around the world.
Now, every node/computer gets a challenging math problem that they need to solve, and whichever computer solves the problem first gets rewarded some bitcoins. This is known as bitcoin mining and the people doing it are known as bitcoin miners.
All the bitcoins that are being supplied to the market are being obtained through mining. Without mining, new bitcoins won’t come to the market. Like if gold is not mined from gold mines, no more gold would be produced similarly bitcoin would have to be mined to generate new bitcoins.
Huge computers are being used to mine bitcoins. Huge server rooms around the world are operating daily in mining bitcoin.
Now let us go to some interesting stuff and see how are bitcoin transactions so secured by blockchain.
As discussed earlier, blockchain stores data in the form of blocks that are connected to each other to form a chain.
In the above image, we can see this is how a block is structured in the blockchain. In a block there are three parts, the first is data, the second is hash and the third is the hash of the previous block. Now let us discuss them in detail.
- Data – Here the details of the transaction are stored, like the name of the sender, receiver, amount of bitcoin, etc.
- Hash – This is a unique feature of the blockchain. Each block contains a unique hash code which is a combination of letters and numbers.
- Hash of the previous block – The block contains the hash code of the previous block as well. But the very first block in the chain does not have a previous block. So that block is known as a genesis block.
Now let us go ahead and see what happens when someone tries to make changes to any block.
As you can see in the above image this is the way in which blocks are arranged in the blockchain. Block-1 is linked to Block-2, similarly, Block-2 is linked to Block-3 and this continues.
Now as I have told you that each block contains the previous hash of the previous block. This is what makes the transaction a lot more secure. Whenever you make some changes to any block, the hash code of the block changes.
Suppose any hacker tries to access Block-2 then, the hash code of the block would change, and then when the hash code of the block would change, the next block containing the hash code of this current block would not match and hence all the following blocks would become invalid and here the chain would break. In this way, the hacker cannot extract information from any block.
But still, this is not enough as today computers are really powerful and they could calculate 1000s of hashes in minutes. So, even if the chain breaks one could easily calculate all the hashes and again build the chain. So, to prevent this blockchain uses a technology called proof-of-work. It slows down the formation of a new block by 10 minutes. So whenever the chain breaks, to create a new block there is a delay of 10 minutes which makes it very hard to build the blockchain again.
Now, the best part is that since this is decentralized when a blockchain breaks no one has to depend upon a single entity to fix the blockchain, any node from around the world can do that.
Best cryptocurrency to invest in 2022
The investment strategy I follow is to invest in the long term. The best ones right now would be Bitcoin and Ethereum. Both have a high market cap and would give good profits in the long run. But keep in mind that do invest by doing proper research first and don’t invest a huge sum of money in the beginning which if you lose you would regret. Invest some small amounts, see the results and then invest further.
So that was all about cryptocurrencies and how they work. Hope you have understood about crypto. If you have any doubts you can put them in the comments and I will reply to you. Thanks for reading.